views December 2015 There is Still Time! Year-End Distribution Considerations Crystal Plum, Manager | Assurance David Hall, Manager | Tax Real estate investors are concerned about their return on investment and distributions play a role in this. Take the time now to consider the tax and financial impact of those anticipated distributions. Financial Statement Considerations Often times real estate entities are required to prepare financial statements not only for their investors, but also for their lenders, regulatory body and others. Each of these parties have different ways of analyzing distributions which are governed by key agreements. There are a few key things to consider: • Have you reviewed your promissory note(s) for any covenants? Lenders will go back to these documents during their review of the financial statements.

Make sure you know your debt covenants, reserve, and cash flow requirements. You certainly do not want to be in violation of a debt covenant or loan requirement thereby giving a lender the opportunity to call a loan and proceed with taking a valuable property from you. Assurance | Tax | Advisory | dhgllp.com • Have your regulatory agreements changed during the year? Review of these documents is a key component of keeping your regulatory agency happy. If you are an affordable housing complex, pay special attention to VHDA, HUD, RD and LIHTC regulatory agreements and their required computation of cash flow and/or surplus cash, as well as any changes to these computations that may have been communicated through notices from the respective body.

For instance, HUD has three versions of regulatory agreements which have three different definitions of surplus cash. RD (Rural Development) places a cap on the maximum amount of cash which can be annually distributed to owners. . views • Distributions can take on different roles depending on the type of entity. Always review the operating agreement in a partnership to verify your distributions are permissible under the terms of the agreement. If you are an S-corporation, it is imperative that distributions are proportionate to ownership as disproportionate distributions could result in the termination of your S-election. • Has the entity done anything during the year that would provide for or require a different distribution of cash to the investors? Partnership and operating agreements have different definitions of distributions based on the type of cash flow. Cash flow generated from a sale or refinance may very likely require a different “waterfall” of cash distributions than that generated from operations. In addition, the Internal Revenue Code and operating agreement may require cash from the sale of a property to be distributed in a manner that comes as quite a shock to many real estate developers.

For instance, cash distributions from operations tend to follow ownership where as the “waterfall” of cash from a sale or refinance may follow capital accounts or different percentages. • As one contemplates making distributions be sure to also verify that there have not been any contributions of property or money to the partnership in the last two years which could run afoul of the disguised sales rules of Code Section 707. Now is the time to run preliminary calculations and get ahead of the game. Consult your tax and accounting professionals to strategize on how to save money, maintain compliance with agreements and avoid headaches before it’s too late. Tax Considerations After considering key factors for financial statements there are a number of tax considerations to keep in mind to avoid unnecessary tax or loss of deduction on distributions. Some important things to consider are: About the Authors Crystal Plum is an assurance manager in the firm’s Norfolk office.  She has more than 10 years of experience in public accounting and concentrates on real estate assurance and attest engagements.

Crystal focuses on affordable housing including compliance matters relating to HUD, VHDA and LITHC projects. She is a member of the real estate industry group within the Hampton Roads area. • Do the owners have sufficient tax basis in your entity to take distributions? This is very easily missed and it is always recommended to consult your tax advisor before making distributions. Not having sufficient tax basis in your investment can lead to an additional tax.

It is not always safe to distribute based on your financial book income as there are numerous book/tax differences which can cause phantom income. David Hall is a tax manager in the firm’s Norfolk office.  He has more than eight years of experience in public accounting and concentrates on real estate partnership and S-corporation tax engagements. He is well versed in the areas of resolving issues with the Internal Revenue Service. He is a member of the real estate industry group within the Hampton Roads area. • Assuming the partners or S-corporation shareholders have basis, distributions can be a useful tool to assist owners with tax liabilities generated from the taxable income of the real estate investment.

No one likes to receive a K-1 with taxable income, but no cash to pay the tax associated with it. Crystal Plum Manager | Assurance 757.624.5167 crystal.plum@dhgllp.com • Have you recently refinanced and distributed cash received from the proceeds? There is a strong possibility of having debt financed distributions when you distribute in a year of a refinance. When this happens a portion of the interest expense could be non-deductible depending on whether the funds were used for personal, investment, or business use. There are many factors that play a role in this calculation, so be sure to inform your tax accountant before year end. Assurance | Tax | Advisory | dhgllp.com 2 David Hall Manager | Tax 757.624.5220 davidb.hall@dhgllp.com .